Terminal Value Techniques in Equity Valuation - Implications of the Steady State Assumption

Joakim Levin and Per M. Olsson ()
Additional contact information
Joakim Levin: Dept. of Business Administration, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, S-113 83 Stockholm, Sweden
Per M. Olsson: School of Business, University of Wisconsin-Madison, Postal: University of Wisconsin-Madison, 975 University Avenue, Madison, Wisconsin 53706, United States of America

No 2000:7, SSE/EFI Working Paper Series in Business Administration from Stockholm School of Economics

Abstract: This paper examines the conditions necessary for calculating steady state terminal values in equity (company) valuation models. We make explicit use of the fact that a company's income statements and balance sheets can be modeled as a system of difference equations. From these difference equations, we derive conditions for steady state. The conditions ensure that the company remains qualitatively similar year by year after the valuation horizon and that it has a stable development of earnings, free cash flows, dividends and residual income. We show how steady state condition violations cause internal inconsistencies in valuation models and how this can have a substantial impact on the value estimates. Steady state is further a necessary condition for a free cash flow valuation, a dividend valuation and a residual income valuation to yield identical results when terminal values are used. The parameters of the model are common accounting and control concepts, and the derived conditions have accounting meaning, linking stock variables in the balance sheet with the flow variables in (and related to) the income statement.

Keywords: equity valuation; terminal value; financial statement analysis (search for similar items in EconPapers)
JEL-codes: G12 G31 M49 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2000-06-30
New Economics Papers: this item is included in nep-cfn and nep-fin
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Citations: View citations in EconPapers (3)

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